Energy Issues
Adapted from theGlobalization101.org Issue Brief
Introduction
Energy usage has been such a basic element of human advancement for so long that it is perhaps not surprising it has acquired mounting significance in the era of globalization. It pervades every aspect of life: enabling the simplest everyday tasks, shaping the environment around us, underpinning economic growth, and increasingly affecting the geopolitical calculations of all governments. In addition, with an estimated $1.7-$2 trillion in annual revenues, the energy industry is the “biggest business in the world; there just isn’t any other industry that begins to compare."
First and foremost, energy in all its forms, perhaps more than any other commodity, has fueled the continuing integration of the nations of the world and their economies. Higher energy consumption has both influenced and been influenced by the forces of globalization, raising the stakes involved in the formation of national energy policies and the proper operation of global energy markets. Strong global economic growth and the need to ship more goods and services around the world have raised demand for energy in many sectors. Such recent spikes in demand, when matched with the declining level of supply in the short term, have created a “shock” that the average consumer feels deeply because high energy prices mean the cost of living rises and energy costs assume a growing share of household spending.
While the exact size of future global energy demand is in constant flux and thus remains uncertain, all trends suggest that consumption of energy will grow at least as steadily as global population. Thus energy issues will only become more prominent in the global dialogue as emerging economies such as China and India continue to modernize and industrialize, and as developed countries place an ever greater premium on securing energy assets and achieving energy independence.
This issue brief will provide an overview to the field of energy, surveying several of the most important types of energy and the issues specific to each type. It will also explore the relevance of energy considerations to three central aspects of globalization: the environment, development, and geopolitics. The brief includes both description and analysis, providing both real-world examples and broader background concepts that contextualize them. Most importantly, the issue brief will address the critical questions and controversies at the heart of the ongoing debate about the role of energy in a globalized world.
Total Consumption
Global energy consumption has increased steadily for much of the twentieth century, particularly since 1950. Today, the world consumes approximately 320 billion kilowatt-hours a day, the equivalent of “22 bulbs burning nonstop for every person on the planet”. Total energy consumption has increased 57 percent globally and 28 percent in the United States since 1980.
U.S. Energy Usage by Sector One of the most notable developments in recent years has been the explosion of growth in energy demand from Asia, which eclipsed North America for the first time in 2003 as the world’s most energy hungry region. Much of this increase in demand came from China and India. In the last few years, China has catapulted itself into second place behind the United States in global rankings with Russia, Japan, India, Germany, Canada, France, the United Kingdom, and Brazil distantly behind. Although China is still far behind the United States, its total consumption is increasing at breakneck speed. With respect to oil, for example, although China’s share of global consumption was only 8 percent, in 2004 it accounted for 35 percent of the world’s increase in annual demand compared with only 25 percent for the United States. Even where the percentages may differ, the absolute numbers describing Chinese demand growth for many types of energy easily rival those of the United States.
Per Capita Consumption
Total consumption is only one measurement of energy usage. Others, such as per capita energy consumption and energy intensity, offer more nuanced information about differences among countries. Per capita energy consumption has remained relatively stable since 1980 both worldwide and in the United States. This indicates that, although the world’s total consumption has increased, most individuals in most countries use about the same amount of energy they did 20 years ago. From this, we learn that much of the increase in total demand can therefore be attributed to population growth and social transformation—e.g. the integration of millions of people into modern, urbanized communities in China and India. With that said, per capita figures reveal important variations in the consumption habits of different societies. If we compare, we find that the average American uses twice as much energy as the average European and up to ten times as much as the average Chinese citizen did in 2002.
Energy Intensity
Energy intensity is a measurement of the amount of energy required to produce a unit of gross domestic product (GDP). This measure is typically calculated on a national basis. It shows that the economic efficiency of energy usage has dramatically improved throughout the world over the last two decades. In 1980, 15,000 British thermal units (Btu) of energy were needed for every dollar of GDP produced in the United States, compared with just over 9,000 Btu in 2004, a 40 percent improvement. All countries, including China, have experienced similar gains in efficiency due to advances in technology and more sophisticated business management practices.
These gains have also been caused by structural change in the economies of many developed countries that have transformed themselves from producers of goods to providers of services. Increased global trade has helped make this possible. Some experts estimate that anywhere from 25-50 percent of improvements to energy intensity in the United States may be a result of the shift from a manufacturing to a services-based economy By the energy intensity measure, energy usage has become more efficient even as total consumption has continued to grow.
The Evolving Concept of Energy Security
Open the daily newspaper, and you are likely to find an article about domestic oil prices or global warming featured prominently. But you are at least as likely to see an article about Russian energy supplies, or the threatened renationalization of an energy company in Latin America, or European worries about energy dependence – in other words, an article about energy security. Concerns about energy security are now at the forefront of many current debates on energy policy, profoundly influencing the way decision-makers think about a range of issues from national and economic security to international diplomacy.
After a long period of relatively cheap energy prices, the tightening of global energy markets in recent years has led energy consuming nations to realize how dependent they are on energy exporting nations that may not share their foreign policy and security agendas. This sense of uncertainty is deepened by the knowledge that many of these exporters are acutely vulnerable to a variety of disruptions beyond their control.
At the same time that anxious energy importers have begun to scrutinize the security of their supplies, the governments of many energy exporters have become more aggressive in reminding trading partners of the leverage they hold. They are also bolder in maximizing the profits that the state realizes from energy sales. The delicate relationship between energy importing nations and energy exporting nations has assumed an increasingly important role in international relations. Stability of supply and demand has become an issue of national security for both parties to this relationship. As New York Times columnist Thomas Friedman has pointed out,
Thinking about how to alter our energy consumption patterns to bring down the price of oil is no longer simply a hobby for high-minded environmentalists or some personal virtue. It is now a national security imperative.
In this context, national security encompasses a broader range of ideas than just defense. This brief will not address defense policy issues specifically, but readers interested in this subject could start by looking at the sections on “Reprocessing and Breeding” (in Appendix D) and “Nuclear Nonproliferation” under “Nuclear Power.” The primary goal of this section is to examine the evolving concept of “energy security” to see how it fits into ongoing debates, particularly those about the need for energy independence.
Energy Security vs. Energy Independence
Many policymakers, particularly in the United States, seem to equate energy independence and energy security, arguing that one will necessarily lead to the other. Much of the political rhetoric of the Bush administration since 2001 has emphasized the need to decrease America’s dependence on oil from the Middle East and increase the stability of the nation’s energy supply, partially by boosting domestic production and partially by relying on new alternative energy sources and technologies, such as ethanol. This focus on energy independence can be misleading. A more comprehensive notion of energy security should take into account three principles that supersede the objective of independence: resilience, diversity of supply, and global interdependence.
Resilience
Resilience is best thought of as a “security margin” that would allow a country to absorb any minor shocks to its energy supply and “facilitate recovery after disruptions.” This “buffer” can take many forms, including “spare production capacity, strategic reserves, backup supplies of equipment, adequate storage capacity along the supply chain, and the stockpiling of critical parts for electric power production and distribution." American proposals to drill in the Arctic National Wildlife Refuge or to boost strategic reserves, for example, are aimed at improving the U.S.’s resilience to threats of foreign supply disruptions.
Diversification of Supply
Rather than fixating on the idea of energy independence, many argue that champions of energy security should think more about how to achieve diversification of supply. If a country can broaden the base of suppliers from which it imports energy, it is less exposed to the risks of a major supply disruption. The United States, for example, has successfully managed to wean itself off complete dependence on the Organization of Petroleum Exporting Countries (OPEC) over the last 20 years, decreasing its share of energy imports from OPEC nations from 72 percent in 1977 to 51 percent in 2000. (For more on OPEC, see section “Oil Supply II: Producers” below.)
At the same time, because overall global supply and marginal prices are the determining factors in the energy prices paid by any country (see the section “Oil Markets” below), diversification of supply does not protect an energy importer from fluctuations in global markets. In other words, diversification of U.S. oil imports is not an adequate answer. Oil is like any other commodity – the last unit sold determines its price. The United States could shift all its purchases to sources that are relatively safe politically, such as Canada and Mexico, and it would still not be protected. The global price is what matters most. Diversification of supply is a vital component of energy security, but only one of several.
Global Interdependence
What has become clear in recent years as both importing and exporting countries have grown more sophisticated in their energy policies is that the new reality of the global energy landscape is one of interdependence far more than independence. According to one commentator, all countries, including the United States,must face the uncomfortable fact that its goal of ‘energy independence’—a phrase that has become a mantra since it was first articulated by Richard Nixon four weeks after the 1973 [oil] embargo was put in place—is increasingly at odds with reality.
All countries are locked into one very tight, very complex global energy market. True security lies in the “stability of this market” for all participants rather than the narrowly defined interest of any one country in what the Washington Post’s Sebastian Mallaby has called the “pipedream of energy independence”.
The key to understanding the concept of energy interdependence is realizing that producers desire security of demand just as much as consumers want security of supply. If, for example, it is true that the European Union imports 30 percent of its energy from Russia, it is also true that Russia depends on the European Union for 20 percent of its natural gas revenues. Both countries have an important stake in the transaction and in the stability of the environment that allows the transaction to occur. Anxiety on either side can lead to heightened tensions and defensive behaviors that not only damage the relationship between individual trading partners but also impact the broader climate of international relations.
Markets are the mechanism by which the competing and complementary interests of importers and exporters are reconciled. In other words, the question is not whether energy and politics are connected but how. We have to find the right balance between a market-driven and a more strategic approach.
The most significant point that emerges from this new perspective on energy security from a policy perspective is that energy consumers should cooperate with each other and with suppliers at least as much as they compete on nationalist or mercantilist grounds. A “resource-scramble” model urges countries to seek what is best for them regardless of the consequences for others. But a more accurate way to think about the problem is to see that each nation’s energy security is an integral part of every other nation’s security.
Take the case of China, for example. China needs vast amounts of energy to fuel the rapid growth of its economy. Consequently, it has been aggressively negotiating energy supply contracts around the world, an action that is viewed by many as a threat to the interests of the United States. Should the U.S. look to its own interests first and foremost or does it have a stake in China’s success? Conventional wisdom might advance the former perspective, but the linkages that have been created by global economic integration make the interdependence model the more relevant one. If China’s economy were to falter because of a lack of energy, the U.S. would be hurt as much as any country: American consumers depend on cheap imports from China to maintain their high quality of life just as much as the U.S. government depends on China and other Asian countries to help finance its deficits. The U.S. and China have a common interest in ensuring that each is able to find the energy it needs to prosper. Traditionally narrow definitions of national interest – still important, but largely a remnant of the pre- globalization era – might ignore this crucial point.
Variable Definition of Security
The definition of energy security is variable, meaning something different for each country. For the U.S., energy security means “producing energy at home and relying less on foreigners;” for China, it might mean “buying stakes in foreign oil fields;” for Russia, it is wrapped up in “restrictions on foreign investment in domestic oil and natural gas;” while for Japan the focus is on “offsetting its scarcity of domestic resources through diversification, trade and investment." It is natural for each country to give priority to its own energy needs, but all of these needs must be reconciled if true energy security is to be attained. According to one expert,
Most producers and all consumers have a shared interest in maintaining a stable, transparent framework in which the pricing mechanism can function as freely as possible. This means no unilateral measures and no ‘politicisation’ of energy exports to punish foes or reward friends.
To this end, a regular ministerial-level dialogue between consumers and producers was initiated in Paris in 1991. These meetings have since evolved into the International Energy Forum (IEF), which held its 10th meeting in Doha, Qatar in April 2006. The IEF focuses on generating “exchange of data, increased transparency of demand and supply information, cooperation between governments and industry, and a better understanding between the two sides of the market”. In a globalized world, energy security will depend on the ability of both consumers and suppliers to cooperate in protecting the stability of global markets.
Types of Energy
In this section, we will consider individually several of the main types of energy and the issues unique to each. Many more topics could be discussed, such as natural gas and electricity markets, but this brief will focus on the role of fossil fuels (oil and coal), nuclear energy, and renewable energy (ethanol, hydrogen, solar, wind, tidal/hydro) in a globalized world. It will consider a range of issues raised by these forms of energy, from the renewed emphasis on clean coal as a vital element of many countries’ energy portfolios to the risks associated with the proliferation of nuclear materials to the potential impact of biofuels on the environment. The goal is to provide a foundation for better understanding of the many energy-related events that are constantly unfolding and the relationship between those events and globalization.
The term fossil fuel is used to describe the broad set of fuels “formed in the earth from plant or animal remains” that have been transformed into raw energy sources over the course of many years as a result of geological processes (1). In effect, fossil fuels are the repositories of millions of years of energy that has been accumulated and shaped into a concentrated form. They are a finite resource that humans were fortunate to discover but whose like they will probably not encounter again. Fossil fuels come in three main forms: petroleum, or crude oil; coal; and natural gas. All have many uses, but each serves one main purpose. Crude oil is refined predominantly to make gasoline for transportation purposes, while most coal is burned by utilities to produce electricity. Natural gas, not covered in this brief because of space limitations, is mainly funneled to industrial sites and factories, though a sizable percentage makes its way into homes for residential heating.
Coal has long been used as an energy source and was the hallmark fuel of the Industrial Revolution. It replaced more traditional sources such as wood (the original biomass, or biofuel) and water power (harnessed by mills). The origins of petroleum as an energy source also date from the middle of the nineteenth century, though it did not really come into its own until the automobile became popular in the United States in the 1910s and 1920s. Oil finally overtook coal as the nation’s leading energy source in the early 1950s. Most early oil exploration occurred in North America, though major deposits were quickly discovered in the Middle East.
In 2003, fossil fuels accounted for more than 85 percent of global energy use. Renewable sources provided around eight percent of the balance and nuclear power about six percent. Within the fossil fuel group, petroleum products accounted for 43 percent of global consumption, coal for 30 percent, and natural gas for 27 percent in 2004. For the United States during this same period, petroleum products represented 47 percent of its fossil fuel mix, coal 26 percent, and natural gas 27 percent. Even with the heightened focus on renewable and nuclear power sources, experts predict that fossil fuels will continue to supply the vast majority of the world’s energy needs for much of the next century.
U.S. Fossil Fuel Usage by Sector
Petroleum products are probably the most widely studied and measured type of energy in the global economy. They come in many different forms, though this is not immediately obvious from news reports that lump them all together under the banner of “oil.”
Crude oil is extracted through wells that tap into underground reserves where oil has been discovered. The extraction process is facilitated by the intense pressure found beneath the earth’s surface. The release of natural gas often occurs alongside oil removal. Once this initial pressure has been relieved, concentrated streams of water, steam, gas or other pumping mechanisms help displace the oil remaining in reservoirs.
Although these techniques have been improved over the last 100 years, significant inefficiencies remain. Using the latest technologies, the average reservoir recovery rate has risen from 20 percent to a still modest 35 percent. This jump in efficiency has greatly increased the global supply of oil, but there is still plenty of room for improvement.
Types of Oil
The quality of crude oil can be assessed in several ways and is an important determinant of how the oil can be used. Depending on the level of the chemical sulfur, crude is classified as either sweet (low sulfur content) or sour (high sulfur content). The ease with which the oil flows during the extraction process indicates whether the oil is heavy (flows with difficulty) or light (flows smoothly). Because heavy crude and sour crude are rawer forms, they are more difficult to process and refine. As a result, lighter and sweeter crudes are generally preferred, and are used to manufacture gasoline and diesel fuel for cars.
U.S. Energy Usage by Oil Type
The density of the oil distinguishes gasoline from diesel fuel. Diesel does not require as much refining as gasoline and is therefore cheaper to produce. Its greater density allows diesel to release more energy when burned, making it a more efficient fuel. On the other hand, this density also results in increased emissions of sulfur and greenhouse gasesthat are harmful for the environment.
Diesel is the preferred automobile fuel in Europe, where rigorous government emissions standards and generous tax incentives have led to the development of diesel engines that are cleaner and more efficient than their gasoline-fueled counterparts. The vast majority of American passenger automobiles, on the other hand, use gasoline, although there has been a movement in recent years to take advantage of the improved performance of the latest generation of diesel engines.
Oil Markets
The global oil market is the most important of the world energy markets because of oil’s dominant role as an energy source. Understanding how it works will also shed light on the functioning of energy markets more generally. What does it mean to say that there is a global market in energy? Fundamentally, oil is a commodity, and contracts for its supply are usually traded through commodity exchanges such as the New York Mercantile Exchange and the Intercontinental Exchange (1).
How much does a barrel of oil cost? What does it mean when newspapers report that oil is selling for $75 per barrel? Such numbers are often cited in discussions of energy policy, yet they fail to convey the complexity of global oil markets. Because it is impossible to synthesize the diversity of oil prices around the world, economists usually refer to benchmarks, a small number of carefully tracked prices that are considered industry standards and against which all other prices can be compared. For oil, the two most common benchmarks are Brent Crude and West Texas Intermediate. Brent Crude is oil “sourced” from the North Sea and is the benchmark against which prices are set for oil coming from Europe, Africa and the Middle East (2). West Texas Intermediate is the price used for contracts traded on the New York Mercantile Exchange and is typically the price that the media has in mind in reports about oil (3).
Breakdown of the Price of a Gallon of Oil in the U.S.
Source: http://money.howstuffworks.com/gas-price.htm
Markets are designed to allocate efficiently resources between those who supply and those who demand a particular product. There are two economic concepts that are important to understanding how supply and demand function in global energy markets: the marginal unit and elasticity.
Marginal Unit and Price
Let’s say a company is currently producing 100 barrels of oil. As the company decides whether to pump out more oil from its stores, it will weigh whether each additional unit of production will be profitable. Each unit that is additional to current production is a marginal unit; the cost of producing this unit is known as the marginal cost, and the price at which it can be sold is the marginal price. What happens at the margins is important because it largely determines the behavior of producers and consumers, thus shaping the market. This principle holds true for all tradable commodities, including oil. In a globalized world where most countries are heavily dependent on a host of foreign suppliers to satisfy their demand for energy and where suppliers are already operating at peak capacity, the marginal unit of production might come from anywhere in the world.
Globalization has, to borrow a phrase from New York Times columnist Thomas Friedman, “flattened” the world, such that the actions of minor oil exporters distant and often unstable countries such Nigeria, Sudan and Iraq can affect the price paid for a gallon of gasoline by consumers in every oil-importing nation. Many advanced economies find these developments destabilizing and therefore threatening. It does not matter where or by whom a barrel of oil is bought or sold: the marginal impact of this transaction will echo around the world. In the end, No private oil company will sell oil to its domestic market for one penny less than it could realize in foreign markets, and the price that a barrel of oil commands will be based on pressures beyond any one government’s control. Because of the influence commanded by the marginal unit, sovereign nations do not have much control over the price of energy. Claims by national governments that energy independence will provide such control are emptier than they might first appear. According to Washington Post columnist Sebastian Mallaby, “Because oil is traded globally, a supply disruption anywhere will affect gas prices” throughout the world. It follows from this analysis that “there’s no use thinking nationalistically.”
The tightness of energy markets in recent years, which stems from high demand and relatively stable supply (see sections on “Oil Demand” and “Oil Supply” below), means there is even less room for a disruption in global supplies, in a world where every single barrel counts, the actions of Chad’s president could threaten global energy security…Because the world is pumping at just about full capacity, the global oil market cannot afford the loss of exports from even the smallest producer. In today’s market, every marginal producer has “unprecedented power and greater geopolitical influence” than ever before. This is one of the reasons why energy issues continue to become more prominent in debates about everything from national economic policies to international diplomacy.
Elasticity
Elasticity is the measurement of how responsive supply and demand are to fluctuations in price. The supply or demand of a good is considered relatively inelastic when price does not have a large effect on production or consumption, respectively. If price does have a significant effect, then the good’s supply and demand are called elastic. If you have difficulty thinking of elasticity in the abstract, imagine a rubber band: if it is easy to stretch and thus responsive to force, it is elastic.
Elasticity is largely determined by the availability of substitutes. If, for example, the price of coffee rose from $1 per pound to $1.10 per pound, consumers who are sensitive to price considerations might switch to tea. If many consumers are willing to switch based on such a relatively small change in price, then the demand for coffee is regarded by economists as “elastic”. If, on the other hand, a 10¢ increase in the price of a pound of coffee did not cause consumers to start buying tea instead, then demand would be “inelastic.” For many forms of energy, such as oil, substitutes are not readily or cheaply available. Demand for oil is thus thought to be generally inelastic, requiring deeper structural changes to impact demand.
There have been many debates about the elasticity of energy supply and demand. A surprising trend to emerge in recent years has been the seeming inelasticity of demand in the face of extremely high energy prices. One way to explain this inelasticity is to take a closer look at the factors driving high prices. Previous price spikes, such as those that occurred during the oil crisis of the late 1970s (see section on “Oil Supply II: Producers” below), were caused by restrictions to global energy supplies, i.e. they were largely driven by supply factors.
In the present oil market, however, high prices are largely a function of record demand, much of which can be attributed to the rise of an energy-hungry China. Because the current situation is demand driven, high prices have not triggered corresponding decreases in consumption. This leads many to believe that the days of cheap energy are over and that expensive energy is here to stay. Others contend that the elasticity of demand will gradually manifest itself. According to one experienced observer,
For years, [economists] thought that petroleum consumption was inelastic and impervious to price fluctuations, only to discover later that this was not the case. In fact, price always affects demand, even if the connection takes time to manifest itself, as consumers try to maintain the lifestyle they are used to for as long as possible.
Consumption patterns will eventually adjust themselves to account for higher global prices. Such an adjustment may already be occurring, as oil prices have begun to moderate in the second half of 2006. In response, OPEC has announced at the end of 2006 that it will reduce production quotas for the first time since April 2004, cutting output by up to 1 million barrels a day to insure against a price drop. To give this figure some perspective: world demand for oil was 80 million barrels a day in 2003 (13). Many future policy decisions will depend on how the question of elasticity is viewed.
Oil Demand
The predominant story line in global oil markets over the last five years has been surging demand. According to one analysis, “This is the first ‘demand-led’ oil shock”. Most of this demand has come from a few countries in Asia (notably China) and from North America (notably the United States). World oil consumption rose by more than 1 million barrels a day in 2005, with 90 percent of this increase attributable to developing countries that are not members of the Organization for Economic Cooperation and Development (OECD). Most of this increase in consumption is driven by transportation and industrial needs. This section will discuss one important factor affecting global oil markets: growth in Chinese demand.
The single biggest factor underlying recent increases in global demand for oil has been China. China needs vast amounts of energy to fuel its rapid annual economic growth rates of 8-10 percent (3). In the transportation sector alone, China is expected to double its demand for oil in the next 15 years as the number of cars in use in China grows fivefold. By 2020, China could be importing up to 70 percent of the oil it consumes, almost double the share it imports now. These new supplies of oil must come from somewhere, and China has been aggressive in securing guaranteed long-term contracts for oil supplies around the world. The tightness of current markets means that supplies from established oil exporters are already going to meet record levels of demand. Therefore, China has been forced to look to more troubled suppliers that other nations have avoided such as Sudan, Angola, and Gabon. China’s strategy has been to use its “soft power” through loans and other diplomatic measures to develop economic alliances with these countries.
Some of China’s new partners, like Sudan, have been deliberately isolated by the international community to achieve strategic geopolitical objectives such as convincing the country’s government to take a more proactive role in curbing the activities of genocidal militias. Many find China’s willingness to “play by different rules” worrisome, arguing that it undermines the efforts of the international community to maintain moral as well as economic authority over rogue states (7). For example, China’s relationship with Sudan has, in the eyes of critics, “crippled the United Nations Security Council’s ability to impose sanctions on the country because Beijing holds a permanent seat and therefore a veto”. U.S. Secretary of State Condoleezza Rice has warned that China’s energy strategy is “challenging…for [American] diplomacy. The success of China in pursuing this strategy has emboldened other countries to show a similar disregard for international norms in their search for energy security: India, another energy-hungry Asian giant, has begun to develop closer ties with the regimes of Myanmar and Iran, both notorious for their poor records on human rights.
Not everyone agrees, however, in condemning China’s behavior. Some believe that Chinese “investment in the development of new energy supplies” should be encouraged because it strengthens global energy security. Such investment is “not a threat but something to be desired, because it means there will be more energy available for everyone in the years ahead as India and China’s demand grows”. The case of Chinese demand is a clear illustration of the complexity of the calculus behind many energy issues. In striving to meet its own individual energy needs in ways that may be objectionable to the international community, China may nevertheless be performing the world an important service.
Oil Supply I: Production
Levels of global oil supply have remained relatively steady over the last decade. Years of low oil prices discouraged investment in developing new production capacity and left producers largely unprepared for recent rises in demand. The oil industry is in the process of adjusting, using part of the flood of new cash from current high prices for research and exploration. These record profits make expensive investments in new technologies and energy sources, such as tar sands and oil shale, more economically feasible (see box “Canadian Tar Sands” below).
More than 70 percent of the world’s proven oil reserves are found in the Middle East or Canada. Among the 20 leading oil producers, eight are members of OPEC and are responsible for 65 percent of global reserves (1). The world’s top ten oil producing nations in 2005 were: Saudi Arabia, Russia, the United States, Iran, Mexico, China, Canada, Norway, United Arab Emirates, and Venezuela. This list differs slightly from the group of leading oil exporters, which does not include the United States or Canada, but does feature Nigeria (#6), Kuwait (#7), and Algeria (#9).
The oil industry has faced growing uncertainty as production has declined in many advanced economies and the world has come to rely more heavily on developing or otherwise unstable countries. American crude oil production, for example, peaked around 1970. Declining production in Indonesia and Norway because of exhaustion of existing fields has been coupled with threats of terrorism in Saudi Arabia, political turmoil in Nigeria and Venezuela, increasing isolationism in Iran, and virtual chaos in Iraq to jeopardize global supplies.
The Question of Spare Production Capacity
In a tight oil market such as the current one, the question of spare production capacity is of signal importance. Does such capacity exist (a) to handle increases in demand and (b) to prevent potential supply disruptions?
For many years, Saudi Arabia, the world’s leading producer and exporter of oil, has served as a critical buffer, what some have called a “central bank of oil.” Saudi reserves are greater than those of Venezuela, Indonesia, Nigeria, and Libya combined (4). It alone maintains high enough levels of spare capacity to guarantee short-term supplies in the event of a disaster (5). Saudi reserves are one of the key pillars of global energy security and a “cornerstone of [American] oil policy” (6). Saudi Arabia has used this excess capacity effectively several times, notably during the Iran-Iraq War (1980-88), both Gulf Wars (1990-1, 2003-present), and various periods of turmoil in Venezuela.
Increased demand has, however, somewhat eroded the value of Saudi Arabia’s spare capacity. According to some experts, “For the first time in decades, production capacity failed to outpace demand, leaving the world with no cushion in case of a sudden prolonged shortage” (7). A chronic lack of investment means that, “The buffer has been in decline for some [time]…The world has been living off the legacy of spare capacity built up many years ago” (8). In response, Saudi Arabia launched a massive $50 billion investment program in 2005 to add significant production capacity by 2009 (9). Huge amounts of capital will need to be poured into the Persian Gulf and invested elsewhere if future reserves are to meet projected demand.
Oil Reserves
Some countries, notably the United States, have addressed the uncertainty caused by slim margins of spare production capacity by creating strategic reserves. The U.S. began to stockpile strategic reserves in 1975, storing the petroleum in large underground salt caverns in Louisiana and Texas. In 1985, the amount of oil stored there was sufficient to handle a supply disruption lasting 118 days. Because of increasing domestic consumption, current reserve levels—688 million barrels as of October 2006—would only last about 59 days.
The U.S. has put is reserves to good use when necessary, most recently in the wake of Hurricanes Rita and Katrina. But, because oil prices are dictated by the global marginal price, when the U.S. opens its reserves, any price benefit “is dissipated around the world.” This is because American reliance on its own strategic reserves will translate into a decrease in overall global demand and thus in global price. Some argue that, contrary to being a “tool of national self-sufficiency,” the use of strategic reserves requires coordination among several key players to be effective. Thus, strategic reserves may be, counter intuitively, a “classic multilateral instrument”.
There has been much debate about whether reserve levels will continue to increase in the coming decades or whether most of the world’s salvageable oil has already been discovered. Proven reserves – “those quantities that geological and engineering analysis suggest can be recovered with high probability under existing technological and economic conditions” – have increased 50 percent between 1973 and 1990 (14). The strength of this trend leads many to believe that future discoveries of additional reserves are inevitable. It is certainly true that the “doomsday” predictions in the 1970s, when major oil companies and the U.S. government suggested oil prices could hit $100-250 a barrel by 2000, have proven largely unfounded.
The rapid pace of advances in science and technology give many hope that the oil industry will one day be able to exploit reserves that are currently considered unsalvageable. The “average oil recovery rate from reservoirs” has risen from only 20 percent thirty years ago to 35 percent today. Even with this improvement, “two-thirds of the oil known to exist in reservoirs is still abandoned as uneconomic, leaving room for tomorrow’s discoveries or innovations to lift recovery rates and magically push [projections of peak global oil production] even further towards the horizon”.
Oil Supply II: Producers
For many years it was large private oil companies that dominated global oil production. In the late nineteenth and early twentieth century, America’s Standard Oil Company, the monopoly created and controlled by John D. Rockefeller, was one of the country’s industrial giants and accounted for almost 90 percent of total American oil sales. In 1911, a Supreme Court decision based on the emerging body of antitrust laws ordered the monopoly to be broken up into 34 smaller companies. Three of these companies – Exxon (formerly Standard Oil of New Jersey), Mobil (formerly Standard Oil of New York), and Chevron (formerly Standard Oil of California) – would eventually join Royal Dutch Shell (Netherlands), British Petroleum (Great Britain), Texaco (United States), and Gulf Oil (United States) to form a group that became known as the Seven Sisters .
The Seven Sisters, some of which merged with each other to form “supermajors”, would control most of global oil production for the rest of the twentieth century. When nationalized oil companies in many oil producing nations began to flex their strength in the 1970s, having learned the trade of oil production from partnerships with private firms, the Seven Sisters and other major private producers survived by investing in more unconventional oil sources in Alaska, the Gulf of Mexico and the North Sea. In recent years, private sector profits have skyrocketed thanks to strong oil prices. ExxonMobil earned the “largest annual profit in corporate history” in FY2005, netting over $32 billion. The supermajors have become so flush with cash that they are having trouble spending it productively.
At the same time, the supermajors are facing increasingly fierce competition from national or renationalized oil companies (see “National Oil Companies” directly below). In an attempt to retain a greater share of oil profits for the state, many of these national oil companies have ended or renegotiated unfavorable terms for longstanding contracts with international partners. Since national oil companies are now in a position to extract oil from conventional sources largely without private sector assistance, the supermajors have seen their role in global production change.
The loss of traditional revenue streams means supermajors must now offer unique specialized services or invest in the development of expensive unconventional oil sources such as tar sands, oil shale, or deep- sea oil if they want to remain globally competitive. So far, such “frontier projects” have not fared well. According to one expert, “The once-proud giants may have to reconcile themselves to shriveling up over time as they fail to replenish reserves.” Though their ultimate fate remains unclear, the supermajors now have the capital to mount significant resistance in what some believe is the “coming age of ‘asymmetric warfare’” against the nationalized oil companies.
National Oil Companies
Most oil producing countries have a national oil company. Oil production is a knowledge-intensive and capital-intensive industry. Therefore it makes sense in many cases for resources to be concentrated in a few firms or a single monopoly. In the early days of oil, governments granted private companies the rights to mine for oil in exchange for the transfer of expertise and technology and for a share of the profits. States formed their own national oil companies to handle their side of the partnership.
As national producers acquired skills of their own, they grew more reluctant to remain minority stakeholders in the natural resources of their own countries. Fortunately for them, they were backed by national governments which had the power to change the terms of partnerships and contracts as they deemed fit. Private companies either had to accept new terms or leave the country, in which case national producers gained sole control over the valuable oil assets.
The case of Saudi Arabia is an illuminating one. In the 1930s and 1940s, various remnants of America’s Standard Oil Company formed a joint venture with the government of the kingdom – the Arabian American Oil Company, or Aramco – to develop the country’s vast oil reserves. The private firms reaped the vast majority of profits from the venture until 1973, when the Saudi government successfully negotiated a 25 percent share. The government continued to consolidate its holdings in Aramco until it secured 100 percent control in 1980, at which time the company’s name was officially changed to Saudi Aramco.
National oil companies now “dwarf’ the supermajors in profitability and reserve holdings. Saudi Aramco, for example, has reserves equivalent to twenty times those of ExxonMobil, the largest private oil producer. At the same time, national companies still cannot match the expertise of the private firms and are unable to fully exploit reserves once the easier initial stages of mining have been completed . There are some exceptions to this rule among smaller, more advanced economies such as Brazil, Norway, and Malaysia. But, in general, the growing power of national oil companies at the expense of private firms translates into less oil on the global market. This trend constitutes a significant threat to the stability of global energy security.
Wave of Renationalization
The recent spikes in oil and natural gas prices have emboldened the governments of several important energy producing nations to pursue an aggressive strategy of renationalizing their energy sectors. While Russia has been notorious for using state power to weaken rivals to the national monopolies in oil (Rosneft) and natural gas (Gazprom), the trend toward “resource nationalism” is most pronounced in Latin America.
The populist governments of Venezuela and Bolivia have not hesitated to renegotiate settled contracts and banish foreign companies. Venezuela alone has secured $31 billion in new revenues for the state using such tactics and alienated several major European producers, including France’s Total and Italy’s Eni. In 2006, Bolivia dispatched its army to seize control of several oil and gas fields, effectively holding them hostage until private partners agreed to renegotiate contracts. The wave of renationalization has significant consequences for international energy security. The general consensus is that, “When national governments strengthen their grip, the outcome is more often than not a deterioration of the country’s industry and a drop in output” . The general population may see some benefits from renationalization in the form of increased social spending, but the primary beneficiaries of such rent-seeking behavior are often government officials and national treasuries . Both the individual country and the whole world are ultimately hurt by resource nationalism and the decreased production it inevitably yields.
Supply Imperfections: Oil Cartels and OPEC
While the demand imperfections we identified in the previous section (see “Oil Demand” above) resulted in fragmentation, the supply imperfections this section will discuss result in a problematic concentration of power. In 1960, a group of the world’s leading oil exporters convened in Baghdad, Iraq to discuss ways of coordinating their production policies. The goal of these countries, as articulated in Article 2 of the chartering Statute of their association, was to develop a common oil policy that would determine “the best means for safeguarding [the] interests [of members], individually and collectively. The group, now known as the Organization of Petroleum Exporting Countries, includes 12 members: Algeria, Angola, Indonesia, Iran, Iraq, Kuwait, Libya, Nigeria, Qatar, Saudi Arabia, United Arab Emirates, and Venezuela. It has been the dominant force in global oil markets since its founding.
The OPEC countries operate as a cartel, “a combination of independent commercial or industrial [actors] designed to limit competition or fix prices”. Each member nation is periodically assigned an export quota that sets the maximum amount of oil they can sell to other countries. Since OPEC controls slightly more than 50 percent of the oil traded internationally, its decisions regarding supply have a tremendous impact on global prices. The cartel can control prices either by (a) directly increasing or decreasing the amount of oil it releases into the market, or (b) merely signaling that a shift in policy is forthcoming. In the estimation of one report, “The very existence of OPEC has influenced conditions in the petroleum market as buyers and sellers await decisions taken at OPEC meetings, and monitor the institution’s behavior”.
OPEC’s charter mentions other objectives that go beyond pure self-interest, highlighting the need to ensure “the stabilization of prices in international oil markets with a view to eliminating harmful and unnecessary fluctuations”. In practice, OPEC has played both a destructive and constructive role in the history of oil prices over the last 30 years.
In 1973, the Arab members of OPEC announced an oil embargo against any country that supported Israel in the Yom Kippur War against Syria and Egypt, including the United States and many European countries. The embargo triggered history’s most catastrophic oil crisis as the price of oil more than doubled almost overnight. Acute shortages led to long lines at the gasoline pump and strict government rationing policies. When the embargo was ended almost a year later, international relations between the West and the Middle East had been severely damaged. Many countries began to take steps to curb OPEC’s power by investing in oil development in non-Arab countries and researching alternative energy technologies.
OPEC played a more constructive role in regulating supplies and prices during the Iranian Revolution in 1979 and the Persian Gulf War in 1990-1, largely thanks to the leadership of Saudi Arabia. The threatened losses of market share and revenue posed by developments in the 1980s led OPEC to increase export levels and stabilize the global market at a reasonable price level. Although OPEC’s power has waned from its peak in the mid-1970s, the group remains a dominant force in the world energy landscape. It will continue to be a key player in the years ahead.
Government Policy
Governments have two types of tools at their disposal with which to moderate the supply and demand of energy: (a) taxes, and (b) standards and regulations. Standards and regulations will be considered in the context of energy and environment (see “Fuel Efficiency Standards” below). This section will discuss two types of taxes: the gas tax and the windfall tax.
Gas Tax
A gas tax is a surcharge levied on every unit of gasoline sold, the proceeds from which go to local and/or national governments. As long as demand for energy is relatively inelastic in the short-run, a fuel tax will provide a stable stream of revenue for the state. Over time, fuel taxes create incentives for people to decrease their energy consumption. Many have criticized the United States, the world’s leading consumer of gasoline, for not effectively using fuel taxes to promote energy conservation. The federal gas tax in the U.S. has remained at 18.4 cents per gallon since 1994. This is supplemented by state taxes ranging from about 10 to 30 cents per gallon, bringing the overall nationwide average tax on gasoline to 45.5 cents.
When compared with much higher taxes in Japan and Europe, where a gallon of petrol or diesel can cost as much as $5-6, it becomes clear that the U.S. tax is not designed to bring about any structural changes in American demand. Some argue the federal tax should be raised to at least 50 cents per gallon and perhaps as high as $1 per gallon. But U.S. political leaders have been reluctant to take the unpopular step of increasing the price of gasoline.
Windfall Tax
Windfall taxes are special taxes a government imposes when it deems the profits made by an industry to be excessive. Such profits often result from a “financial windfall” such as a spike in oil prices. The U.S. government levied a windfall tax against oil companies in 1980 following the Arab oil embargo, and talks of another round of windfall taxes were revived during congressional hearings in November 2005 Senator Pete Domenici (R-NM), then chairman of the Committee on Energy and Natural Resources, has said, “Oil companies have failed to tell us and show us what they are doing with these profits that justify them” While windfall taxes can be a boon to government treasuries and give the impression of an active government response to high oil prices, most observers believe such actions are ultimately detrimental to the nation’s energy security. These taxes mostly serve to curb investment, raise prices, and distort long-term incentives. Worse, they purport to be able to distinguish between a healthy level of profits and an ‘excessive’ one—something specialist antitrust authorities, not greedy governments, are best placed to judge. So far, there has been no legislative follow up to the hearings.
Although coal is a fossil fuel, it has little in common with oil. Oil is extremely scarce, but coal is relatively plentiful. Some expert analyses predict that global coal reservescould last as long as 190 years. While oil is mostly found in unstable parts of the world, coal stocks are widely distributed on every continent and found in abundance within the borders of many of the globe’s largest energy consumers. Almost 60 percent of global coal reserves are located in the United States, China, and Russia, and various estimates hold that the United States has enough coal deposits to satisfy its needs for 250 years. According to David Weidman, chief executive of chemical company Celanese, “Coal is easy to access, it’s in politically stable regions, and the technologies exist to eradicate environmental impacts…It’s been an underappreciated feedstock for much too long” (3).
While coal has long been an important element of the global energy mix, the great debate in recent years has focused on its future role as the nations of the world attempt to curb their harmful emissions and wean themselves off fossil fuels. One coal-fired electricity plant, for example, provides enough power for 500,000 homes but also releases as much pollution as 750,000 cars. The coal industry has been revitalized in recent years by U.S. President George W. Bush, who has embraced so-called “clean coal” technologies as a way to harness an available resource in an environmentally sustainable way. In the United States, at least, prominence on the president’s agenda has sent the coal industry booming and led to “the most ambitious construction of coal-fired electricity plants since the 1950s”).
Clean Coal
Clean coal technology is a broad term used to describe a series of processes that remove most of the pollutants when coal is burned, thus making it a more environmentally friendly energy source. There are three primary processes covered under the heading of clean coal: the integrated gasification combined cycle (IGCC), carbon capture, and carbon sequestration. During the IGCC, coal is crushed and mixed with steam to produce a combustible fluid that is clean of many pollutants such as sulfur and mercury. When this fluid is used to make electricity, which it does far more efficiently than traditional coal-fired turbines, carbon dioxide is released as a byproduct and filtered out for later disposal (6).
An alternative to IGCC is carbon capture, a method by which normal coal-fired plants are retrofitted with special absorbers that soak up carbon dioxide for subsequent storage. Various capture techniques can also be used when oil or natural gas is initially extracted from the ground. At that stage, huge amounts of carbon dioxide, which form “a proportion of the fossil fuel in its natural state,” are released into the atmosphere. The extraction process is itself one of the major sources of greenhouse gas emissions.
Once carbon dioxide has been isolated and contained using IGCC or another capture method, it is then converted into a “highly concentrated stream” or “‘supercritical’ state between a liquid and a gas” and stored deep underground. Typically, these streams are pumped into the ocean floor or into old oil or gas reservoirs. Sites capable of storing carbon dioxide in this form must be “deep, porous…covered by a layer of impermeable rock to prevent leakage.”
Some fear that earthquakes or other geological disturbances could destabilize the storage areas. While leakages could have dire consequences for the environment, there is no way to judge what the level of risk is with any certainty. Many supporters of renewable energy sources argue that clean coal and carbon sequestration technologies, while sounding promising, are untested and have limited potential in the near term. Despite being trumpeted by President Bush, few “zero-emissions” plants are being planned.
Some critics feel the idea of clean coal is a “smokescreen, since it’s not intended to bring technology to the market at the pace required to deal with the problem.” It is estimated that retrofitting old coal-fired plants or building new ones equipped with clean coal technology would add anywhere from 5-20 percent to the cost of electricity. The future of clean coal will ultimately hinge on whether these costs will prove acceptable to power utilities and consumers.